4 profit levers to boost your business: The 4L3M framework for consumer brands

Tweak the 4 levers to impact the 3 margins

Until this point, we've discussed concepts like contribution margin, marketing efficiency, fixed operating expenses and discounting in isolation. Now we'd like to take a more holistic view of your profit and loss (P&L) statement and introduce the "4 levers, 3 margins" approach to improving your profitability.

The 4L3M Framework

First, let's start with the "4 levers". These are inputs that you can exert some level of control over.

1. Price: can you raise prices without a significant hit on demand?
2. Variable costs per unit: can you reduce product, freight, fulfilment or transaction costs?
3. Ad spend: can you improve your ad performance and spend less to acquire customers?
4. OpEx: can you trim OpEx and avoid unnecessary bloat?

Improving one or multiple of these levers should lead to a better outcome for your "3 margins"

A. Gross margin

B. Contribution margin

C. Operating profit margin

Diagnose your P&L bottom-up

To improve the profitability of your business, you should start from the bottom and work upwards. Avoid the temptation to do this in reverse by chasing top-line revenue and hoping everything else works itself out.

Set a target for operating profit margin

Set a target operating profit margin. The exact target you set can very depending on what category you operate in, as we've outlined in our Profits in Focus eBook. For example, a best-in-class Food & Beverage brand might aim for a profit margin of 16%, while a company selling Health supplements could aim for 26%.

Trim your OpEx spend

The first lever we encounter as we work bottom-up is OpEx. The question to ask yourself here is: can I trim OpEx and avoid unnecessary bloat? And because OpEx is inflexible and difficult to change month-over-month, you need to make some long-term decisions about how you operate your business. In practice, this could mean keeping your full-time headcount low and having a roster of contractors on hand for seasonal peaks. We dive deeper into the advantages of keeping a lean OpEx in a separate article.

Consider your break-even point in units

Remember, your contribution margin is expected to cover your fixed operating costs at the very least. Assuming you've trimmed your OpEx spend as much as possible and have set a target spend level, you should now ask yourself: how many units do I need to sell to break-even?

break-even point = fixed operating costs / contribution margin per unit

For example, if your OpEx is $100,000 per month and you earn a contribution margin of $10 per unit, then you need to sell 10,000 units just to break even.

Assess your marketing efficiency

A point we've laboured before is: Don't judge your marketing metrics in isolation. Look at how they impact your P&L. Your marketing function shouldn't be a stand-alone team tasked with maximising an isolated metric like MER (Marketing Efficiency Ratio) or ROAS (Return on Ad Spend). They should be treated as an important lever with a real impact on financial outcomes.

In assessing what "good" marketing performance looks like, it can be helpful to start with what a "bad" approach might be. That is, spending on ads that don't contribute positively towards your bottom-line profit. Take MER, for example. Too many operators take the simplified view of "our MER is going up, so let's spend more on ads" when they should be asking themselves "is my next dollar of ad spend going to earn me more profits?". To run a profitable business, you need a nuanced understanding of marketing efficiency that takes contribution margin into account. Make sure to calculate your break-even MER and make decisions based on how your actual performance compares to this.

break-even MER = selling price / gross profit

Exceeding your break-even MER is just the baseline. There is plenty of improvement that lies beyond that. You can use our benchmarking tool to get an indication of how your category peers perform across metrics like MER, ROAS, CTR (click-through rate) and CPC (cost-per-click). From there, you should start to go deeper and look at specific campaigns and creatives. Are your ads earning the click? Are your conversion funnels optimized to turn that click into a purchase?

Once again, nuance is the name of the game here. Don't draw false conclusions by comparing the CTR and CPC of ads side-by-side. These metrics vary depending on how you've designed the ad funnel. In general, you want good continuity between your ad and the post-click landing page experience, period. But there are slightly different ways you can approach this. For example, a product-focused ad set might aim to convert very quickly, pointing you towards a checkout-style page that makes the transaction quick-and-easy. Another ad set might try "earn the click" with an eye-catching headline that points you towards longer-form educational content. In this example, the former would have a lower CTR, higher CPC and higher post-click conversion. The latter would attract lower intent traffic, so you could expect a higher CTR and lower CPC, but lower post-click conversion.

In summary, you should make sure your marketing efficiency exceeds your break-even MER so that you're generating a positive contribution margin, then look to optimize so that your margins expand even further.

Adjust your cost structure to improve gross margins

Having strong gross margins earns you more wiggle room for the levers we've just discussed, namely marketing spend and fixed operating costs. You should make it a habit to scrutinize each variable cost that eats into your gross margin, like product costs, freight charges or fulfillment fees. Could you find a cheaper supplier without hurting product quality? Can you manage inventory turnover better so fulfillment costs don't rack up? Can you negotiate cheaper shipping costs? These are questions that should be routinely visited.

Make sure the price is right

The most obvious way to boost contribution margin per unit is to start at the top and increase the price you charge. Ask yourself: what would happen if I nudged prices up? The likely outcome is that sales volume will decrease, but a higher price will reduce the number of units you need to sell to break-even. It's all about managing this trade-off and avoiding a scenario where your pricing strategy is actually leaving profits on the table.

If you're a brand that discounts frequently, ensure you are discounting with a clear idea of how it's going to affect your profitability. Indiscriminate discounting at the busiest times of year is a great way to make more sales, but for many brands, it's also a surefire way to hurt profitability.